I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful – Warren Buffet
This is a famous quote from Warren Buffet’s book, titled ‘Think like Warren Buffet’ where he was practically giving advice on how to become a wise investor. A quick glance through various search engines on the words investor, investment and invest automatically brings up words such as stocks, shares and shareholders. Talking about financial investment and knowing how to invest wisely often times involves dealing with stocks. Now for some of you, you probably have come across the word before and perhaps know certain things about what it entails, while for some other people, you are not so acquainted with it. We are going to be brushing up on what stocks mean and take you on a quick tour on understanding how stocks works.
So what is a stock? Stock simply means a share in the ownership of a company. In simpler terms, it means being one of the owners of a company. Owning stocks in a company means you are entitled to its earnings (which is the amount of money that particular company has earned during a specified period) and assets (refers to an element of economic value belonging to the company and which is expected to produce a benefit in future periods). You might have come across words such as equity and shares, they both mean the same thing as stocks. Now let us delve further into what owning a stock means. Owning a stock or shares in a certain company means you own a part of that company. So the higher the shares you own in that company, the corresponding higher percentage you own in that same company.
Now for regular folks like you and I, owning a share in a company, let’s say for example, Pepsi, does not mean we can go into any of the company’s outlets and begin to order the staffs around, and sorry to ‘burst your bubble’ again, it doesn’t also mean you get free pepsi cola drinks whenever you want at any of their outlets. It doesn’t really work that way. What it technically means is that you own a piece of every trademark of that company, buildings, furniture, equipment and also, earnings of that company. Your entitlements are majorly two things; the earnings and voting shares. Earnings has been simply and briefly explained earlier on, while voting shares simply means the particular shares that bestows the shareholder with the right to vote on matters of corporate policy making as well as electing those who will constitute the board of directors.
The proof of your ownership of a particular stock is the stock certificate. It is a swanky piece of paper which ideally represents your stock. Several years back prior to the emergence of portable computers and internet services, stock certificates were almost always in the possession of the owners of the stocks. This was the medium which stocks were being traded. To buy or sell your shares in a company, you must have your stock certificate with you as this serves as the proof of your ownership. But today, you don’t have to have your stock certificate physically with you as it is electronically stored. This makes it safer to keep and easier to trade with. Having learnt what a stock certificate means, the next thing you should know are the types of stocks.
There are basically two main smorgasbord of stocks, Common Stock and Preferred Stock. The common stock is the most likely type of stock you would have heard, read or watched being talked about. Majority of stockholders deal with this type of stock. It basically means what we’ve been talking about; having a part in the ownership of a particular company with a claim to its profits and also with the ability and opportunity to participate in voting in members that will constitute the board of directors. With common stock, you also get to be paid dividend (a distribution of a company’s earnings to its shareholders) depending on the amount of profit the company is raking in. Preferred stock is a ‘special’ type of stock where shareholders are assured of a fixed dividend. The stock also doesn’t have the same voting rights as the common stock. In short, it differs from the common stock mainly in two ways; having a fixed dividend as opposed to the variable dividends associated with common stock and also, not having the same voting rights.
We’ve discussed what a stock is, the meaning of stock certificate and likewise the major types of stocks. Now let’s talk about how people make money by investing in the stock market. When you buy a common stock, you have two major source of generating income. The first way is through dividends as we talked about earlier. This is when the board of directors of the particular company that you have invested in decides to pay you a certain amount of money as part of the profit they made. This is usually proportional to the amount of shares you have in that company. So basically, you get a higher dividend than someone with a lower amount of shares in that same company. You should also know that there is no rule that says a company must compulsorily pay you dividend, although a lot of companies do. Secondly and most importantly, you can generate income by selling your shares at a higher rate than they originally were. For example, you buy 1000 shares at a company at the rate of N20 per share. This means you have N20,000 worth of shares invested in that company. As the company grows and becomes more profitable with the aid of a good management team, great product or service and exceptional marketing skills, potential investors and regular folks see this as a good investment and likewise invest in that company. Gradually, the naira per share value of that company will rise, let’s say to N100, so automatically your naira worth in that company becomes N100,000. You can decide to cash out your N100,000 by selling your shares to an interested buyer through a broker (an individual or a firm behooved with the role of matchmaking buyers to sellers and vice versa).
Trading of stocks is done through an exchange, which is an avenue for buyers and sellers of stocks to meet and discuss the price of the particular stock involved. There are two types, the physical exchange and virtual exchange. The physical exchange involves a trading floor where transactions are carried out. You might have seen something similar depicting this in a movie or news channel, where men and women wearing suits or jackets waving their hands up and yelling out certain words and numbers to each other. The other type, which is the virtual exchange, involves trading electronically. There are virtual brokerage firms that allows the investor the liberty and comfort of trading from anywhere they want through the use of mobile devices, tablets or computers. The exchange can be compared to an e-commerce site such as Konga, which links up buyers to sellers and vice versa. In Nigeria, the stock exchange is known as the Nigerian Stock Exchange (NSE) while in the United States, the major stock exchanges are the NYSE (New York Stock Exchange), NASDAQ and AMEX (American Stock Exchange). The NYSE is an example of the physical exchange; while NASDAQ is a virtual exchange where trading is done electronically with no floor brokers or any central location. London houses the popular London Stock Exchange, Hong Kong Stock Exchange (HKEX) is the major stock exchange in Hong Kong while Brazil is home to BM&F Bovespa.
Let me conclude by indulging you on the reasons why companies issue out stocks to individuals or institutional investors. You ever wonder why these companies will want to share ownership of their companies and subsequently share their profits? The reason is that at some point every company needs to raise capital. They might need to raise capital for a big and extensive project they are working on, to expand their business or simply to service off a debt. So instead of going to the bank to get a loan to fulfill the capital need of their projects or expansion plans, they sell off a certain percentage of their company. This works well with the companies as they are not required to pay back any debt or interests incurred on the debt. When a company decides to sell out part of its company to the public for the first time, it is called an Initial Public Offering (IPO). Individuals and institutional investors buy shares during the IPO of some companies in the hope that those shares will be worth more than they originally were after a while. This is where the distinction comes between the two entities Primary Market and Secondary Market. The primary market involves buying shares from a company during its IPO, while in the secondary market, investors trade previously issued shares/stocks. When people refer to the stock market, most of the times, they are referring to the secondary market.